Democrats target income tax breaks to balance budget

Gov. John Kitzhaber and House Speaker Tina Kotek, D-Portland, support evaluating the effectiveness of Oregon's income tax breaks, which Democrats hope will help fund schools this session.The Associated Press

It's an only-in-Oregon tax break: If you're 62 or older, you can deduct the full cost of your medical expenses on your income taxes -- plus the full cost of the medical expenses of your spouse.

It's a great deal for seniors, but with medical costs ballooning and the boomers aging, the state's cost for the deduction is multiplying. In 2013, Oregon will lose an estimated $85 million to the deduction. Over the next eight years it's expected to cost nearly $1 billion.

That's why the senior medical deduction, as it's called, is a poster child for state lawmakers who want to chop tax breaks to raise more money for schools.

But there's another reason Gov. John Kitzhaber and other Democrats want to rein in the medical deduction: High-earning taxpayers benefit the most.

While 26 percent of those taking the deduction earned $77,000 a year or more in 2010 -- putting them in the top 20 percent of Oregon taxpayers -- they were responsible for 59 percent of the revenue impact.

Numbers like those are common among the 211 income tax breaks on the books in Oregon. The Oregonian analyzed 32 of those "tax expenditures," representing $1.3 billion in lost tax money and found about half of it went to those in the upper fifth of the income scale.

In the intense debate over inadequate school budgets, runaway pension costs and increasingly expensive prisons, ratcheting back on tax breaks could be an escape valve. When the Legislature convenes Monday, Oregon's smorgasbord of tax breaks will get far more scrutiny.

"We see that as one of the critical pieces of achieving a balanced budget and finding the dollars necessary for our schools," says House Speaker Tina Kotek, D-Portland. "I think a lot of Oregonians support that."

Democrats took control of the House in a fall election where they told voters they'd protect teachers and class sizes, upping political pressure to find more revenue for schools. There aren't many easy answers on the table.

Kitzhaber's proposed budget raises money for schools, but does so with $860 million in cuts to the Public Employees Retirement System. Even with those cuts, which face legal challenges and pit Democrats against their union allies, some school districts say they would still have to lay off teachers.

Chuck Bennett, lobbyist for the Confederation of School Administrators, said a survey of 15 school districts shows the state would need to allocate $6.6 billion to $6.7 billion dollars over the coming two years to avoid further teacher layoffs, bigger classrooms or shorter school years. That's about half a billion dollars higher than Kitzhaber proposed.

"I know these numbers are high. I know they're difficult to talk about," Bennett said. "But if people want the truth, that's the truth."

Lawmakers are still bruised from the 2010 political fight over Measures 66 and 67, which raised income tax rates on high-earning individuals and corporations. Most seem to have written off new taxes for schools. That leaves few options.

Raising $500 million in revenue by trimming tax breaks will be difficult.

Tax activists point to the mouth-watering figure of $36 billion that Oregon will "spend" through various tax breaks over the next two years. But that number includes some biggies that are either mandated by federal law or simply too difficult to collect. Examples: the $13.7 billion exemption for intangible personal property, such as bonds and savings account balances, and the $2.2 billion exemption of property taxes for federal lands.

Removing most income tax breaks from the books is technically easier. Oregon will collect roughly $6 billion in income taxes this year. If it weren't for income tax breaks, the state would collect twice that. But each credit and deduction has a built-in constituency ready to save it from the chopping block. Go after the mortgage deduction, for instance, and an army of Realtors, homebuilders, homeowners and others would descend upon the Capitol.

Furthermore, any cut to tax breaks is legally a tax increase. That means it requires a three-fifths vote in both chambers of the Legislature. Democrats are two votes shy of that in the House and the Senate.

Lawmakers are looking for a sweet spot that raises money while avoiding politically fatal outrage.

"It's a difficult combination of finding things that are both politically viable and big enough to be worth the fight," Unger says. "Every one of these is going to be a fight."

There's also political heat in who gets cut. Credits, such as college tuition or the earned income credit, are available to anyone who files taxes, including lower-income people. Deductions, such as medical expenses, mortgage interest and property taxes, primarily benefit higher-income taxpayers who itemize their tax returns.

"A lot's going to depend on the PERS issue," she says, "because PERS and health care are the two drivers of the cost of government."

Difficult path to cuts

Every tax break has a story.

In 1999, the Legislature established a tax deduction for contributions to the Oregon 529 College Savings Network. The goal was to help families save for college. In the first year, 8,000 Oregonians set up accounts. Today $1.6 billion has been set aside in 130,000 accounts.

The tax break, used by fewer than 2 percent of tax filers in 2010, cost the state $6 million in tax revenue that year. Of that, 87 percent went to filers with adjusted gross incomes of more than $77,000 -- more than twice the state's median of $32,500.

"If anything, you (should) deny it to the top 20 percent," Sheketoff says. "Those people have the means to be able to save for college."

But Michael Parker, executive director of the college plan, says the number-one reason people don't go to college is because they can't pay for it. Even families who might be considered upper income sometimes have a difficult time saving enough to cover tuition payments, Parker says. State tax breaks give them an incentive.

"When we do market research, far and away the chief reason people are saving for college in these plans is because they get a tax incentive," Parker says. "If there was no tax benefit, they would put their money somewhere else."

The senior medical deduction also goes mostly to higher-income taxpayers.

Lawmakers installed the deduction in 1991 to help elderly Oregonians pay medical expenses.

Burdick believes needy seniors can be helped in better ways than using a tax deduction, which she would prefer to cut.

"It's not just taking something away from old people," Burdick says. "It's trying to have a more rational system to helping elderly people who really need it."

Applying a $5,000 cap to the senior medical deduction would produce only $6.2 million in revenue over the next two years. A $3,000 cap would produce $26.1 million. High earners would take most of the hit.

Capping the breaks

It would take a lot of individual cuts -- and political fights -- to create enough savings to give the state budget a significant boost.

Kotek, the House speaker, has openly questioned the value of allowing Oregonians to claim the deduction on their second homes. But limiting the break to a primary residence would produce only $37 million over the next two years. Capping total deductions at $50,000 would produce $283 million over the same period.

"People who have $50,000 in deductions tend to have a couple hundred thousand dollars of income," Wiser said. If the state capped deductions, "you are automatically capping the mortgage interest deduction at the same time."

If legislators settled on a cap, they'd likely face many requests for exemptions from charitable organizations and other interests that benefit from tax deductible gifts. The governor is a firm believer in state tax incentives to make movies and TV in Oregon, and he wants to increase the earned income tax credit that helps low-income earners.

Whether the Legislature settles on a list of targeted breaks, an overall cap or a series of votes on individual deductions, it will be a hard sell for some lawmakers.